Emerging Markets: What has Changed

(from my colleague Dr. Win Thin) 1) Brazil extended its FX intervention program through at least June 30 but changed the daily amounts 2) China's cash crunch continues, with the 7-day repo rising to 6.6% and the highest since the last serious crunch in June 3) The Reserve Bank of India kept rates steady, but was expected to hike policy rates by 25 bp 4) Political risks in Turkey have risen after the corruption-related arrests this week 5) Turkey's central bank kept all rates unchanged, but reduced the maximum amount of liquidity it will provide markets 6) Hungary's Supreme Court ruled that foreign currency loans are valid contracts, and that the borrowers will have to shoulder the burden of any harmful FX movements 7) Colombian central bank minutes from the November meeting showed that some saw scope for further easing Over the last week, Hungary (+2%), Peru (+3%), and Russia (+3%) have outperformed in the EM equity space in local currency terms, while Turkey (-5.5%), Colombia (-3%), and China (-3%) have underperformed. In the EM local currency bond space, Turkey (10-year yield up 38 bp), Brazil (up 20 bp), and Czech Republic (up 17 bp) have underperformed over the last week, while Indonesia (10-year yield down 24 bp), Hungary (down 17 bp), and Poland (down 16 bp) have outperformed. In the EM FX space, HUF (+1.3% vs. EUR), CLP (+0.2% vs.USD) and CNY (flat vs. USD) have outperformed over the last week, while ARS (-2.0%), TRY (-1.5%), and IDR (-1.5%) have underperformed vs. USD. EM FX clearly does not like the idea of Fed tapering. Despite the notion that global investors have already made portfolio allocation adjustments away from EM during the period after Bernanke's first taper scare on May 22, price action suggests otherwise. The dollar's fortunes against the majors have been mixed of late, but against EM, the greenback has largely gained as tapering expectations picked up in Q4. We believe this trend will continue in Q1 2014, with the so-called Fragile Five (BRL, IDR, INR, TRY, and ZAR) likely to continue under-performing.1) Brazil extended its FX intervention program through at least June 30 but changed the daily amounts. BCB will now auction $200 mln daily in FX swaps, with FX credit line auctions depending on "liquidity conditions of the FX market." Currently, BCB auctions $500 mln of swaps daily Monday-Thursday and an additional $1 bln from the FX credit line on Fridays. This move lowers the degree of predictability and increases the amount of discretionary intervention. With EM FX set to come under further pressure as the Fed tapers, we do not think this was the right signal to send. A better one would have been to either maintain current amounts or even increase them slightly.2) China's cash crunch continues, with the 7-day repo rising to 6.6% and is the highest since the last serious crunch in June. PBOC added liquidity to the system today, but not by enough to fully ease funding pressures. Select institutions reportedly received CNY200 bln of injections, but the PBOC would not specify which ones. Still, the repo rate is well below the June peak near 10.77%. Year-end seasonal pressures appear to be the culprit, but it comes at a time when the authorities are also trying to liberalize interest rate markets. As such, markets remain jittery.3) The Reserve Bank of India kept rates steady, but was expected to hike policy rates by 25 bp. RBI Governor Rajan said the decision was a "close call." He has delivered two straight rate hikes, and a third was seen as November CPI came in much higher than expected. WPI came out earlier this week at 7.5% y/y vs. 7.0% consensus, pointing to stronger pipeline price pressures. There are clearly further upside risks to CPI, which rose 11.2% y/y in November vs. 10% consensus and 10.1% in October. Rajan called this spike "temporary" and this seems to be taking a calculated gamble. For now, it appears to be working. However, with EM expected to remain under pressure, there is a risk that the rupee will eventually suffer from this decision to keep rates steady.4) Political risks in Turkey have risen after the corruption-related arrests this week. The number of detained has risen to 84, and those accused include some high level executives as well as family members of Cabinet officials (Interior, Economy, and Environment Ministers) and the CEO of state-owned Halkbank. Rather than being a rift between the ruling Islamic AKP and the secularists like we saw in the June Gezi Park protests, we appear to be witnessing instead a widening rift between the AKP and followers of cleric Fethulla Gulen. Erdogan dismissed nearly 50 police chiefs today in what can be seen as a retaliatory move against those that are supporting Gulen. This struggle is likely to be quite extended, as local elections in March will be followed by the presidential election in August.5) Turkey's central bank kept all rates unchanged, but reduced the maximum amount of liquidity it will provide via the PD facility (roughly from TRY23 bln to TRY6.5 bln) and via 1-week repos (from TRY10 bln to TRY6 bln). It said it would keep the weighted cost of funding at 6.75% or more, which is different than the previous meeting, when it said an average cost of funding of 6.5% was consistent with the desired interbank money market rate of 7.75%. By relying on such opaque measures, we fear that Turkey is losing what little credibility that it had regained in recent months. A better signal would have simply been to hike rates in a clear manner, especially with the lira coming under pressure again. With the fundamentals remaining poor, TRY now looks set to underperform again after outperforming within EM recently.6) Hungary's Supreme Court ruled that foreign currency loans are valid contracts, and that the borrowers will have to shoulder the burden of any harmful FX movements. Prime Minister Orban wants the banks to take most of the hit, so financial stocks rallied sharply along with the forint. The central bank cut rates 20 bp to 3%, as expected, and said further easing may follow. However, it noted that the pace may be slower. Note that it cut rates from 4% to 3% in 20 bp increments over the past five months, slowing from the 25 bp pace seen in the move from 7% to 4%. It has cut 17 straight months, which must be some sort of record.7) Colombian central bank released minutes from the November meeting last Friday, which showed that some members of the board saw scope for further easing. Rates have been on hold since March. The economy is showing signs of softness still, with IP, retail sales, and exports all largely stagnant. As such, we think there is a risk that the easing cycle will restart in 2014 if the slowdown continues. The bank meets this Friday, but we think this is too soon to see a rate cut.